Narayan AmmachchiThe Mexican peso (MXN) has been gaining ground in the currency markets over the past couple months, eating into the profits of service exporters who tend to negotiate cross-border contracts in US dollars.
The Mexican peso began the year being sold at 19.44 units per dollar in the currency markets, according to data by Yahoo Finance. As of August 28, it sold for 16.80 units per dollar. That is, the value of the Mexican currency climbed 13% in eight months.
One year ago today, the Mexican peso was exactly 20 to 1. pic.twitter.com/lWk2VSBYJN
— My Latin Life 🌴 (@MyLatinLife) August 29, 2023
Although Mexico’s federal government has celebrated the performance of the so-called “super peso”, a strong national currency has left many Mexican nearshore vendors with less lucrative contracts once they make the USD-to-MXN conversion.
Some nearshore vendors might even consider contract renegotiations with clients.
“We’ve seen IT outsourcing contracts with Mexican firms for several years now, and have closely seen the implications of currency fluctuation, especially the recent strengthening of the Mexican peso on cross-border contracts,” said Todd A. Jacobs, Chief Information Technology Officer at audit remediation firm CodeGnome Consulting.
“In my opinion companies may look to reassess existing contracts to account for a stronger peso,” added Jacobs. “Some US-based companies might start to explore other offshore markets to mitigate those costs. This could alter the power dynamics between vendors and customers, especially when it comes to contract renegotiation.”
The outlook was shared by Gabriela Siller, Director of Economic and Financial Analysis at Banco BASE.
“In the mid-term, export prices will adjust, for sure, which might cause Mexico to lose some of its competitive edge,” stated Siller.
What’s Behind the ‘Super Peso’?
Several factors have been driving up the value of the peso in recent months.
First and foremost is the belief that many US companies may shift their manufacturing units from China to Mexico amid the growing bilateral clashes between Washington and Beijing.
Wall Street speculators have been buying pesos in the hope of seeing a rise Nearshoring in the short term, explained Siller.
Mexico has also received the highest amount of remittances this year. In the month of May alone, Mexico received a record US$5.7 billion in remittances, according to the Bank of Mexico (Banxico). Annually, the country gets around $60 billion in remittances.
Some analysts also point to Mexico’s fiscal balance, which remained healthy even at the height of the pandemic.
Another reason for the peso’s strength is the interest rate differential between Mexico and the United States.
“Banxico’s monetary policy has been quite restrictive, keeping a wide difference in relation to the rates established by the Fed in the US,” said Siller.
Mexico’s central bank has raised interest rates more quickly than the US Federal Reserve, so Mexican assets are now more attractive to investors. Benchmark rates in Mexico are currently around 11%, compared to 5.5% in the United States.
Can the Super Peso Keep Going?
Investors are also buying into the peso in hope that the Federal Reserve might soon cut interest rates, which normally drags down the dollar index.
However, the Fed is less likely to cut interest rates until inflation decreases to less than 3%. With the US supply chain still in turmoil, the chances of inflation returning to pre-pandemic levels appear quite remote.
“The exchange rate usually rebounds a bit by the end of the year. We could see it closing 2023 in the 17.10-17.30 per dollar range,” Siller said.
Jose Roberto Solano, market analyst with Mexican financial group Monex, also sees the peso loosing some of its steam by the end of the year, though his outlook puts the peso’s value at 17.80 units per dollar before the onset of 2024.
Additionally, if the expected nearshoring of manufacturing does not materialize, it could reverse the scenario.
“If investors lose interest in the peso, they might flee in search of other options, causing a rebound in the exchange rate,” Siller added.
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